Standard Costs and Variance Analysis

INTRODUCTION

This document focuses on two related topics: the development and use of standard
costs, and the calculation and interpretation of variances, i.e. the analysis of deviations
from those standard costs in the actual results.

STANDARD COSTS

Definition and Purpose of Standard Costs

A standard cost is a carefully predetermined cost. Narrowly defined, it is the estimated

cost to manufacture a single unit of a product or to perform a single service. More
broadly defined, it is the estimated cost of a product, job, project, or operation, including
manufacturing, selling, and administrative costs.

A budgeted cost is a standard cost multiplied by a volume figure. In other words, a

standard cost is a unit cost while a budgeted cost is a total amount, although the terms
are often used interchangeably.

Because standard costs are incorporated into budgeting systems, they play a key role in
the planning, control, motivation, and performance evaluation functions of management.
Having predetermined costs provides timely information to help managers plan and
make decisions about product emphasis, bidding, and pricing, since such decisions
often have to be made before production is complete. For control purposes, standard
costs allow for a detailed analysis of variances between actual performance and
budgeted performance, to determine where inefficiencies or problems exist. Because
standard costs provide concrete targets that employees can aspire to achieve, they can
also be used to motivate employees to minimize inefficiencies and to correct problems.
Commitment to attaining standards is usually enhanced when employees have been
involved in setting the standards. Finally, evaluation of performance against
predetermined standards is generally perceived to be fairer than evaluation based on
vague expectations.

Standard costs may provide additional benefits if they are incorporated into the
accounting system. A standard costing system, also known as a standard cost
system, is an accounting system that uses standard costs to accumulate material,
labour, and overhead costs. Standard costing systems are often more practical than
actual or normal costing systems, and simplify the accounting process and records. For

Copyright © 2007. The Society of Management Accountants of Canada.

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example, subsidiary ledgers need only record the quantities of raw materials on hand,
since their associated cost is the standard cost.

Types of Standard Costs

Two types of standard costs exist. Ideal standards, or theoretical standards, reflect a
situation where there is maximum efficiency, i.e. where employees always work
efficiently, the best quality materials are always available, input prices are the lowest
possible, machines never break down, power failures never occur, etc. (Currently)
attainable standards, or practical standards, reflect efficient performance within
realistic or normal operating conditions. They are more flexible than ideal standards
because they allow for normal spoilage, ordinary machine breakdowns, and lost time,
etc.

Most organizations use attainable standards since they are believed to be more
effective in motivating employees to perform well. Use of ideal standards may
discourage employees from trying to meet standards that are perceived to be
unattainable and may lead to sacrificing product quality in an effort to reduce costs.
Nevertheless, ideal standards are useful for organizations pursuing a continuous
improvement strategy or facing a crisis that requires extraordinary efforts. When ideal
standards are used, employees can be evaluated on and rewarded for satisfactory
progress towards the ideal standards.

Development of Standard Costs

Developing standards for direct materials costs involves selecting the desired
combination of quality, quantity, and price. Setting standards for labour costs requires
understanding the nature of the work and the skill levels of employees. Developing
standards for overhead costs involves the selection of a valid cost allocation base and a
reasonable level of activity. The organization may use a single plant-wide rate or
multiple departmental rates.

Several techniques are available to develop standard costs:

1. Activity analysis (or task analysis) – Identify and evaluate all activities required to
complete a product, job, or operation to determine exactly how much direct materials
should be required, how long each step performed by direct labourers should take,
and how machinery should be used in the production process, etc.
2. Historical data – Use historical data in conjunction with management judgment to
ensure that standards do not perpetuate past inefficiencies.
3. Benchmarking – Collect information from other firms in the same industry or firms
considered to have “best practices” across industries.
4. Market expectations and strategic decisions – Determine the standard required
to achieve a target cost or to achieve satisfactory progress towards a continuous
improvement strategy.

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A competitive global marketplace has resulted in increasing use of the last two
methods, along with or instead of the traditional first two methods.

VARIANCE ANALYSIS

Variance analysis is the process of measuring and evaluating actual performance

against standards or budgeted performance targets. Static-budget variances, or
master-budget variances, are the differences between actual amounts and static-
budget amounts. Static-budget variances are of limited use since they compare a cost
or revenue result against a budget that typically reflects a budgeted volume level that
usually differs from actual. For example, it may compare a budget of 100 units to an
actual output of 80 units.

Two additional types of variances can be calculated based on the flexible budget. A
flexible budget restates the master budget using the achieved level of production and
sales. Flexible-budget variances are differences between the actual results and the
flexible-budget amounts for the actual output achieved. To use the same analogy as
above, a budget output of 80 units would be compared to an actual output of 80 units.
Sales-volume variances are differences between the flexible-budget amounts and the
static-budget amounts. See Appendix A for variance formulas.

By convention, variances are computed by subtracting the budgeted or standard

amount from the actual amount. Variances are favourable when they result in an
increase in profit; they are unfavourable when they result in a reduction in profit.
Therefore, positive cost variances are unfavourable since actual costs exceed budgeted
costs; and negative cost variances are favourable since actual costs are less than
budgeted costs. Similarly, positive revenue variances are favourable since actual
revenues exceed budgeted revenues; and negative revenue variances are unfavourable
since actual revenues fall short of budgeted revenues.

Flexible Budget Variances

Direct Materials and Direct Labour Cost Variances

Flexible-budget cost variances for variable costs are divided into two components: price
variances and efficiency variances. Price variances, also known as rate variances
(especially in the case of labour), capture the change in profit resulting from differences
between the standard price for a unit of material or labour and the actual price paid.
Efficiency variances, also known as usage or quantity variances, measure the
change in profit resulting from differences between the actual amount of materials or
labour used and the amount that should have been used based on the standard
quantity allowed for the actual output.

The relationship between the price and efficiency variances has to be considered when
evaluating these variances since there are often tradeoffs to be made. In particular,
higher-priced raw materials may be of a higher quality and result in production

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efficiencies, whereas lower-priced raw materials may be of an inferior quality and lead
to more spoilage and scrap. Similarly, if higher wages for direct labour reflect higher
levels of skills and experience, employees may be more productive. As well, there are
usually inter-relationships between materials and labour variances. For example, better
quality materials may be easier to use, and highly-skilled employees may be more
careful and efficient in their use of materials.

Some organizations calculate the materials price variance based on actual quantity of
inputs purchased rather than used, since the purchasing group is accountable for
materials price variances while the production group is accountable for efficiency
variances. However, basing both price and efficiency variances on usage makes it
easier to consider how the two are interrelated and is more appropriate in just-in-time
environments where coordinating the purchase and usage of materials is essential.

Decomposing Material and Labour Efficiency Variances: Mix and Yield Variances

An organization may be able to use varying proportions of different raw materials (e.g.
different types of fruit to make canned fruit salad) and/or different grades or skill-levels
of labour. When inputs can be substituted such that the proportions of the inputs are
different than the budget proportions, material and labour efficiency variances can be
further decomposed into mix and yield variances. The mix variance reflects the effect
on income of substituting inputs that have different standard costs. The yield variance
reflects a combination of the efficiency loss or gain from not using the standard mix of
inputs and any other efficiency losses or gains in the process.

Variable Overhead Spending and Efficiency Variances

While the calculation of overhead spending and efficiency variances parallels that of
materials and labour, interpreting these variances is more complicated.

Variable overhead price variances are usually referred to as spending variances. In

practice, variable overhead variances are determined by department and by cost pools
so that management can examine each item that is out of line.

The variable overhead spending variance is a composite factor that may be caused by
changes in prices of variable overhead items such as supplies, utilities, and
maintenance, as well as efficient or inefficient use of the variable overhead items (e.g.
turning off machines when they are not in use, spilling supplies).

The variable overhead efficiency variance formula assumes that there is a clear-cut
proportional relationship between the underlying cost driver (e.g. direct labour hours,
machine hours, number of units produced) and variable overhead expenses. Therefore,
an unfavourable overhead efficiency variance will arise when more units of the cost
driver are used than budgeted. Conversely, there will be a favourable overhead
efficiency variance whenever fewer units of the cost driver are used than budgeted. If
the cost driver is direct labour hours and more labour hours are used (perhaps because

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employees are less experienced than expected), it is assumed that consumption or use
of variable overhead items such as supplies and indirect labour (supervision) will
increase in proportion to the increase in labour hours. If the cost driver is machine hours
and more machine hours are used, it is assumed that variable overhead costs will
increase proportionately to the increase in machine hours because more electricity will
be used, maintenance will be performed more frequently than budgeted, etc.

Fixed Overhead Cost Variances

In a standard costing system, a predetermined rate for applying fixed overhead costs is
calculated based on total expected fixed factory overhead and total expected activity for
the year. Thus, fixed factory overhead is applied as though it were a variable cost, yet
the fixed overhead rate per unit is only applicable for one specific volume level.

The flexible budget for fixed overhead is identical to the master budget as long as the
flexible budget activity level is within the relevant range. Furthermore, no fixed overhead
efficiency variance is computed since, in the short-run, fixed overhead is not affected by
efficiency—that is why it is categorized as fixed.

At year end, there will be a difference between actual factory overhead costs and
applied factory overhead costs. This overapplied or underapplied overhead can be
subdivided into a spending variance and an output-level variance.

The fixed overhead spending variance, or budget variance, is similar to the variable
overhead spending variance. It is the difference between the amount actually spent and
the amount budgeted to be spent. Since fixed costs are often beyond immediate
managerial control, the spending variance does not measure managerial performance
in most cases.

The output-level variance, or production-volume variance, results from unitizing

fixed costs. It is the amount of fixed overhead that is overabsorbed or underabsorbed by
the products as a result of operating at a level that differs from the production level used
to calculate the predetermined overhead rate. The output-level variance measures the
cost of not producing up to the master-budget capacity or the benefit from better-than-
budgeted usage of plant resources. This variance is only calculated under an absorption
costing system since fixed overhead is a period cost under a variable costing system.

Sales-Price Variances

Sales-price variances (or selling-price variances) measure the change in income

resulting from actual selling prices being different than budgeted prices. Although sales-
price variances are one of two main types of sales variances (the other being sales-
volume variances), they are flexible-budget variances. Sales-price variances may reflect
competitive factors over which a firm has little control, but they may also reflect
problems with the perceived attractiveness of a firm’s products or services compared to
those of competitors.

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Sales-Volume Variances

The sales-volume variance measures the change in income resulting from actual
sales volume being different than budgeted sales volume.

Decomposing the Sales-Volume Variance: Sales-Quantity Variance and Sales-Mix

Variance

In multiple product firms, the sales-volume variance can be decomposed into a sales-
quantity variance and a sales-mix variance.

The sales-quantity variance calculates the change in profit resulting from a change in
the quantity of products sold. The sales-quantity variance can be separated into a
market-share variance that isolates the impact of capturing more or less market-share
than budgeted and a market-size variance that isolates the impact on the firm’s profit
of a change in the overall market size.

The sales-mix variance measures the change in profit resulting from a change in the
mix of products sold. A favourable variance indicates that the actual sales mix included
a higher than budgeted proportion of products that have higher contribution margins. An
unfavourable variance indicates an actual sales mix with a higher proportion of products
that have lower contribution margins.

Cautions About Variance Analysis

Variances indicate that something is different than expected, but they do not tell
management what went wrong. There are many possible causes of variances. For
example, an unfavourable direct materials efficiency variance could be caused by poor
design of the product and/or manufacturing process, problems with the quality or
availability of materials from suppliers, carelessness on the part of employees,
inadequate training of employees, inappropriate assignment of labour or machines to
specific jobs, scheduling congestion due to rush orders, overly-optimistic standards,
and/or errors in recording raw materials usage.

Variance analysis is further complicated by the inter-relationships among variances. For

example, the purchase of poor quality materials may result in a favourable materials
price variance but an unfavourable materials efficiency variance. It may also slow down
workers, resulting in an unfavourable labour efficiency variance. In turn, if labour hours
are the cost-allocation base for variable overhead, there will also be an unfavourable
variable overhead efficiency variance.

Finally, variances tell only part of the story. They tell management whether the
organization performed better or worse than planned, but they do not tell management
how much better or worse the situation could have been. For example, although the
materials price variance was unfavourable, it is possible that the situation could have
been much worse if the purchasing department had not taken a number of measures to

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counteract rising material costs, such as placing larger orders with fewer suppliers.
Alternatively, a favourable sales-quantity variance does not reveal how many additional
sales opportunities were lost due to complacency on the part of sales managers.

When investigating variances, the emphasis should be on determining the causes of the
variances with a view to taking corrective action and learning how to improve future
operations. If too much emphasis is placed on blaming managers rather than
understanding the underlying problems, managers may be motivated to inflate
standards or distort actual results.

Not all variances warrant investigation. Most organizations use a materiality threshold,
such as a prescribed dollar amount, a prescribed percentage of the standard cost, a
combination of these two size thresholds, or a statistical guideline. However, other
criteria besides materiality should be considered. These include whether the benefits of
investigating the variance outweigh the costs, whether the variance is consistently or
repeatedly occurring, whether there has been a trend in the variance over a period of
time, how important the item is to the production process or service experience, and
whether someone in the organization has the ability to control a particular cost or
revenue.

Although many of the examples cited in the previous paragraphs refer to unfavourable
variances, it is also important to investigate significant favourable variances as a
possible cue that standards were set too low or that circumstances have changed
enough to warrant the development of new standards. For example, employees may
have developed a better way of performing a specific task, or new machinery may offer
significant efficiencies.

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Sample Problem to Illustrate Calculation and Interpretation of
Variances

Ferguson Foundry Limited (FFL) manufactures two models of wood stoves, Basic and
Deluxe. The company has a good sales force and achieved record profits in 2006.
FFL’s president, Mark Ferguson, has just reviewed the financial statements of FFL for
the fiscal year ended May 31, 2007. The results for the year were both a shock and a
disappointment. Despite having sold more stoves than anticipated, profits had declined
from 2006 and were significantly below the budgeted amount.

The following information is available: a statement of budgeted and actual results

(Exhibit A), a statement of standards costs prepared last year (Exhibit B), and some
market and job-cost data (Exhibit C).

Mark Ferguson has requested a report from FFL’s newly-hired controller explaining why
the company did not meet its budgeted profit level for fiscal 2007.

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 Exhibit A
Static Budget and Actual Results
For the Year Ended May 31, 2007

Static Budget
Basic Deluxe Total
Sales volume (in units) 4,500 5,500 10,000
Budget Selling Price/Unit $300 $800
Sales revenue $1,350,000 $4,400,000 $5,750,000
Variable costs:
Direct materials 315,000 1,045,000 1,360,000
Direct labour – unskilled 126,562 412,500 539,062
– skilled 278,438 907,500 1,185,938
Overhead 202,500 660,000 862,500
Selling and administration 67,500 220,000 287,500
Total variable costs 990,000 3,245,000 4,235,000
Contribution margin $ 360,000 $1,155,000 $ 1,515,000
Fixed costs:
Manufacturing 750,000
Selling and administration 132,500
Total fixed costs 882,500
Operating income $ 632,500

Actual Results
Basic Deluxe Total
Sales volume (in units) 7,200 4,800 12,000
Sales revenue $2,340,000 $3,360,000 $5,700,000
Variable costs:
Direct materials 486,000 820,800 1,306,800
Direct labour – unskilled 320,040 508,781 828,821
– skilled 428,760 681,619 1,110,379
Overhead 374,400 595,200 969,600
Selling and administration 108,000 192,000 300,000
Total variable costs 1,717,200 2,798,400 4,515,600
Contribution margin $ 622,800 $ 561,600 $1,184,400
Fixed costs:
Manufacturing 780,000
Selling and administration 139,500
Total fixed costs 919,500
Operating income $ 264,900

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 Exhibit B
Unit Cost Standards
For the Year Ended May 31, 2007

Basic Wood Stove Deluxe Wood Stove

Direct materials:
Standard quantity per unit 70 kilograms 190 kilograms
Standard price per kilogram $1.00 $1.00
Direct labour:
Standard quantity per unit 6 hours 16 hours
Unskilled labour 2.25 hours 6 hours
Skilled labour 3.75 hours 10 hours
Standard rate per hour
Unskilled labour $12.50 $12.50
Skilled labour $16.50 $16.50
Variable overhead:
Standard quantity per unit 6 hours 16 hours
Standard rate per hour $7.50 $7.50
Variable selling and
administration rate per unit $15.00 $40.00

Exhibit C
Market and Job-Cost Data
For the Year Ended May 31, 2007

Market Data:
Expected total market sales of wood stoves 100,000 units
Actual total market sales of wood stoves 133,333 units

Summary of Job Cost Sheets:

Basic Deluxe Total
Units of wood stoves produced 7,200 4,800 12,000
Direct materials:
Actual quantity used in kilograms 540,000 912,000 1,452,000
Actual price per kilogram $0.90
Direct labour:
Actual hours worked 46,800 74,400 121,200
Unskilled 25,200 40,061.5
Skilled 21,600 34,338.5
Actual rate per hour
Unskilled $12.70 $12.70
Skilled $19.85 $19.85
Actual variable overhead allocated
on the basis of direct labour hours $374,400 $595,200 $969,600

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 Solution to Sample Problem

Memo
Date: June 30, 2007
To: Mark Ferguson, President
From: C.M. Accountant, Controller
Re: Fiscal 2007 Performance against Budget

Ferguson Foundry Limited’s (FFL) profit in 2007 was $367,600 lower than budgeted
despite having sold 2,000 more wood stoves. This report will rely primarily on variance
analysis to determine the reasons why the company did not meet its profitability goals.

As shown in Exhibit 1, the actual contribution margin of the Basic model in 2007 was
$6.50 more than the predetermined standard, due to a $25 increase in the selling price
that more than offset the $18.50 increase in variable costs per unit. On the other hand,
while the actual cost of the Deluxe model was $7 lower than the standard cost, this
model was sold for $100 less than the budgeted price, resulting in an actual contribution
margin that was $93 below standard. A more detailed breakdown of these changes and
their impact on profit will be provided in the subsequent analysis of variances.

Exhibit 2 provides a summary of the two main types of variances. Flexible-budget

variances are due to costs or selling prices being different than standard. They
summarize the difference between actual results and a flexible-budget that is based on
the actual sales quantity of 12,000 units. Sales-volume variances result from selling
more than the budgeted volume of 10,000 stoves. The unfavourable flexible-budget
variance of $436,600 and the favourable sales-volume variance of $69,000 can both be
broken down into detailed variances, as summarized in Exhibit 3. The calculations for
these variances are shown in Exhibit 4.

The reasons for FFL’s profit being significantly below budget can be divided into
marketing-related and production-related factors, as also summarized in Exhibit 3.

Marketing-Related Factors:

1. Price Changes – The positive effects of increasing the price of the Basic model by
$25 (8.3%) were outweighed by a $100 (12.5%) reduction in the price of the Deluxe
model. The overall impact of price changes was a $300,000 reduction in FFL’s profit,
as shown by the Sales-Price Variance. The reason for the large reduction in the
price of the Deluxe model should be investigated. It could reflect decreasing demand
for this model, increasing competition, an overly-optimistic standard price, and/or the
fact that FFL’s Deluxe model is becoming less attractive to consumers than
comparable models offered by competitors.

2. Change in Mix of Sales – FFL sold more Basic models and fewer Deluxe models
than budgeted. Basic models comprised 60% of the actual sales volume, instead of

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 the budgeted 45%, while Deluxe models comprised only 40% of actual sales instead
of the budgeted 55%. Since the Deluxe model has a higher standard contribution
margin per unit ($210 versus $80), the different mix of sales reduced FFL’s profit by
$234,000, as shown by the Sales Mix Variance. The increased proportion of Basic
models sold may reflect changing consumer tastes, mistaken estimates of the
relative demand for the two models, less competition in the Basic model segment of
the industry and more intense competition in the Deluxe segment, and/or the fact
that FFL’s Deluxe model is not well received in the marketplace while its Basic
model is. These same factors have been identified as possible reasons for having to
reduce the price of the Deluxe model, since there may well be common causes for
both the decline in the demand for the Deluxe model and the need to reduce its
price.

3. Decreased Market Share in a Growing Total Market – FFL’s profit was $303,000
higher than budgeted due to selling 2,000 more stoves than budgeted, as shown by
the Sales Quantity Variance. Although this is positive, the increased sales quantity
can be attributed solely to benefiting from a 33% increase in the size of the market
for wood stoves. Based on its budgeted market share of 10%, the overall increase in
profit due to the increase in the size of the market was $505,000, as shown by the
Market Size Variance. The fact that FFL obtained only a 9% market share, instead of
10%, reduced this amount by $202,000, as shown by the Market Share Variance.
The combined impact of obtaining a 9% share of the larger market was a $303,000
increase in profit.

4. Increased Selling and Administration Costs – Although the variable selling and
administration costs were right on standard, an increase in the fixed costs reduced
profit by $7,000.

Production-Related Factors:

1. Direct Materials Price and Usage – The favourable Direct Materials Price Variance
of $145,200 indicates that FFL experienced substantial savings in direct materials
costs during 2007. This may have resulted from volume discounts that were not
considered in setting the standards and that arose as a result of the higher
production volumes. However, the unfavourable Direct Materials Usage Variance of
$36,000 indicates that FFL used more materials than budgeted. This suggests that
the lower-priced materials may have been of a lower-quality that resulted in more
wastage.

2. Direct Labour Price and Usage – The unfavourable Labour Rate Variance of
$200,446 reflects that FFL’s wages were higher than budgeted. In particular, skilled
workers were paid $19.85 per hour instead of the budgeted $16.50, and unskilled
workers were paid $12.70 per hour instead of $12.50. The large wage increase for
skilled employees reflects an industry-wide shortage of skilled foundry workers,
something that apparently was not anticipated when setting the standard wage
rates. If the skilled wage was higher than the industry average, it may also indicate

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 that FFL has difficulty attracting employees, and the reasons for this should be
investigated. On the positive side, FFL was able to use a higher-than-standard
proportion of unskilled labourers (almost 54% versus the standard of 37.5%),
increasing net income by $79,246, as shown by the Labour Mix Variance. However,
using more unskilled labour reduced the overall productivity of the workers, who took
a total of 121,200 hours to produce 12,000 stoves instead of the 120,000 hours
dictated by the standards. This reduced net income by $18,000, as shown by the
Labour Yield Variance.

3. Variable Overhead Price and Usage – Since direct labour is also the cost driver for
variable overhead, the unfavourable Variable Overhead Usage Variance of $9,000
simply reflects the usage of more hours to make the stoves. The unfavourable
Variable Overhead Spending Variance of $60,600 may reflect inefficiencies in the
use of overhead (such as leaving lights or machinery on when not in use) and/or
higher-than-expected rates for electricity, supplies, or supervisory salaries, etc. The
size of this variance may indicate that the budget did not accurately reflect current
rates for various overhead items.

4. Fixed Cost Increases – Fixed manufacturing costs increased by 4%, reducing net
income by a total of $30,000. This increase may have been necessary given the
increased volume and change in production mix. Perhaps increased investment in
machinery, supervisory staff or other fixed costs may have been required to
accommodate the increased sales volume. It should be determined whether these
higher costs are expected to continue in the future.

Summary

Overall, in terms of marketing-related factors, it appears that FFL’s budget projections

were not based on an accurate assessment of the industry. In particular, FFL
underestimated the growth in the size of the market. FFL also appears to have
misjudged the market’s preference for Deluxe versus Basic models of wood stoves. FFL
should study the market environment more carefully to ensure that both its production
plans and marketing efforts are appropriate directed in the future.

From a production perspective, FFL’s manufacturing costs were significantly higher than
budget due primarily to the large increase in the skilled labour rate, along with higher
variable and fixed overhead costs. Although some potential causes for these increases
have been outlined above, further investigation is warranted to determine the exact
causes. Since the increase in the skilled labour rate may be largely outside of FFL’s
control, it may be prudent to assess the feasibility of either redesigning the production
process to permit heavier reliance on unskilled labour without any loss in productivity or
using internal training programs to increase the proportion of skilled labourers in FFL’s
employ.

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CONCLUSION

This document has illustrated how the use of standard costs enables a firm to perform
detailed variance analysis to help explain differences between actual profits and
budgeted profits. Variances are best thought of as “symptoms” of problems;
investigation is required to identify the causes of these problems.

REFERENCES

Blocher, Edward J., David E. Stout, Gary Cokins, and Kung H. Chen, 2008, Chapters
13, 14, and 15, Cost Management: A Strategic Emphasis, Fourth Edition, McGraw-Hill
Irwin, New York, New York.

Horngren, Charles T., George Foster, Srikant M. Data, Howard D. Teall, Maureen P.
Gowing, 2007, Chapters 7, 8, and 16, Cost Accounting: A Managerial Emphasis,
Fourth Canadian Edition, Pearson Education Canada, Toronto, Ontario.

Horngren, Charles T., Gary L. Sundem, William O. Stratton, Howard D. Teall, George A.
Gekas, 2007, Chapter 12, Management Accounting, Fifth Canadian Edition, Pearson
Education Canada, Toronto, Ontario.

Mallouk, Brenda, Gary Spraakman, 2006, Chapter 5, Managerial Accounting, Second

Canadian Edition, Nelson Education Ltd., Toronto, Ontario.

Weygandt, Jerry J., Donald E. Kieso, Paul D. Kimmel, and Ibrahim M. Aly, 2006,
Chapter 11, Managerial Accounting: Tolls for Business Decision-Making, Canadian
Edition, John Wiley & Sons Canada, Ltd., Mississauga, Ontario.

CMA Canada 14
 Exhibit 1
Contribution Margins

Actual Standard Actual Standard

Basic Basic Deluxe Deluxe
Selling price $325.00 $300.00 $700.00 $800.00
Variable costs:
Direct materials 67.50 70.00 171.00 190.00
Direct labour – Unskilled 44.45 28.13 106.00 75.00
- Skilled 59.55 61.87 142.00 165.00
Overhead 52.00 45.00 124.00 120.00
Selling & administration 15.00 15.00 40.00 40.00
Total variable costs 238.50 220.00 583.00 590.00

Contribution margin $ 86.50 $ 80.00 $117.00 $210.00

Exhibit 2
Flexible Budget Report
For the Year Ended May 31, 2007 (in $’000s)

Flexible- Sales-
Actual Budget Flexible Volume Static Total
Results Variances Budget Variances Budget Variance
Quantity (units) 12,000 12,000 10,000
Sales revenue $5,700.0 $(300.0) $6,000.0 $250.0 $5,750.0 $ (50.0)
Variable costs 4,515.6 (99.6) 4,416.0 (181.0) 4,235.0 (280.6)
Contribution 1,184.4 (399.6) 1,584.0 69.0 1,515.0 (330.6)
margin
Fixed costs 919.5 (37.0) 882.5 882.5 (37.0)
Net income
before tax $ 264.9 $(436.6) $ 701.5 $ 69.0 $ 632.5 $(367.6)

Notes:
1. The amounts shown in brackets represent unfavourable variances.

2. The flexible sales revenue is computed as using the using the standard selling price per unit
and the actual sales volumes as follows:
Basic wood stove = $300 x 7,200 = $2,160,000
Deluxe wood stove = $800 x 4,800 = 3,840,000
Total $6,000,000

3. The flexible budget for variable costs is computed using the standard per unit costs and the
actual sales volumes as follows:
Basic wood stove = $220 X 7,200 = $1,584,000
Deluxe wood stove = $590 x 4,800 = 2,832,000
Total $4,416,000

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 Exhibit 3
Summary of Variances

Flexible Sales-
Budget Volume
Variances Variances
Sales variances:
Sales price $300,000 U
Sales mix $234,000 U
Sales quantity
– Market share $202,000 U
– Market size 505,000 F 303,000 F
Sales volume 69,000 F

Total sales variance $300,000 U $69,000 F

Variable cost variances:
Direct materials – Price 145,200 F
– Usage 36,000 U 109,200 F
Direct labour – Rate 200,446 U
– Usage
– Mix 79,246 F
– Yield 18,000 U 61,246 F 139,200 U
Overhead – Spending 60,600 U
– Usage 9,000 U 69,600 U
Selling & administration 0
Total variable cost variance 99,600 U
Total contribution margin variance 399,600 U
Fixed cost variances:
Manufacturing budget 30,000 U
Selling and administration budget 7,000 U
Total fixed cost variance 37,000 U

Total variance $436,600 U $69,000 F

Note: F = Favourable; U = Unfavourable

CMA Canada 16
 Exhibit 4
Variance Calculations

Flexible-Budget Variances

Direct materials price variance:

Basic: ($0.90 - $1.00) X 540,000 kg = $ (54,000) F
Deluxe: ($0.90 - $1.00) X 912,000 kg = (91,200) F

$(145,200) F

Direct materials usage variance:

Basic: (540,000 - 7,200 X 70) X $1.00=
(540,000 - 504,000) X $1.00 = $36,000 U
Deluxe: (912,000 - 4,800 X 190) X $1.00 =
(912,000 - 912,000) X $1.00 = 0

$36,000 U

Direct labour rate variance:

Basic:
Unskilled ($12.70 - $12.50) X 25,200 = $ 5,040 U
Skilled ($19.85 - $16.50) X 21,600 = 72,360 U
Deluxe:
Unskilled ($12.70 - $12.50) X 40,061.5 = 8,012 U
Skilled ($19.85 - $16.50) X 34,338.5 = 115,034 U

(rounded to nearest dollar) $200,446 U

Direct labour usage variance:

Basic:
Unskilled (25,200 - 7,200 X 2.25) X $12.50 = $112,500 U
Skilled (21,600 - 7,200 X 3.75) X $16.50 = (89,100) F
Deluxe:
Unskilled (40,061.5 - 4,800 X 6) X $12.50 = 140,769 U
Skilled (34,338.5 - 4,800 X 10) X $16.50 = (225,415) F

$(61,246) F

Direct labour mix percentages:

Actual: Standard:
Basic: Unskilled 25,200 / 46,800 = 53.8461% 2.25/6 = 37.5%
Skilled 21,600 / 46,800 = 46.1539% 3.75/6 = 62.5%
Deluxe: Unskilled 40,061.5 / 74,400 = 53.8461% 6/16 = 37.5%
Skilled 34,338.5 / 74,400 = 46.1539% 10/16 = 62.5%

CMA Canada 17
Direct labour mix variance:
Unskilled: (53.8461% - 37.5%) X 121,200 X 12.50 $247,643 U
Skilled: (46.1539 - 62.5%) X 121,200 X $16.50 (326,889) F

$ (79,246) F

Direct labour yield variance:

Unskilled: [121,200 - (7,200 X 6 + 4,800 X 16)] X
37.50% X $12.50 = $ 5,625 U
Skilled: [121,200 - (7,200 X 6 + 4,800 X 16)] X 12,375 U
62.50% X $16.50
Direct labour
yield variance $18,000 U

Variable overhead spending variance:

Basic: [($374,400 / 46,800 hours) - $7.50] X $23,400 U
46,800 =
Deluxe: [($374,400 / 46,800 hours) - $7.50) X 37,200 U
74,400 =

$60,600 U

Variable overhead usage variance:

Basic: (46,800 – 7,200 X 6) X $7.50 = $27,000 U
Deluxe: (74,400 – 4,800 X 16) X $7.50 = (18,000) F

$ 9,000 U

Variable selling and administrative variance:

(7,200 X 15) + (4,800 X 40) - 300,000 = $0

Fixed manufacturing cost spending Variance:

780,000 – 750,000 = $30,000 U

Fixed selling and administration cost spending variance:

139,500 – 132,500 = $7,000 U

Sales-price variance:
Basic: 7,200 x ($325.00 - $300.00) = 7,200 x $180,000 F
$25.00 =
Deluxe: 4,800 x ($700.00 - $800.00) = 4,800 x 480,000 U
$(100.00) =

$300,000 U

CMA Canada 18
Sales-Volume Variances

Sales-volume variance:
Basic: (7,200 – 4,500) X $80 = 2,700 X $80 = $216,000 F
Deluxe: (4,800 – 5,500) X $210 = (700) X $210 = 147,000 U

$ 69,000 F

Sales-quantity variance:
Basic: (12,000 – 10,000) X (4,500 / 10,000) x $ 72,000 F
$80 =
Deluxe: (12,000 – 10,000) X (5,500 / 10,000) X 231,000 F
$210 =

$303,000 F

Budgeted average contribution margin per unit = $1,515,000 / 10,000 = $151.50

Market-share variance:
133,333 X [(12,000 / 133,333) – (10,000 / 100,000)] X $151.50 =
133,333 X (9% - 10%) X $151.50 = $202,000 U

Market-size variance:
(133,333 – 100,000) x .10 x $151.50 = $505,000 F

Sales-mix variance:
Basic: (7,200 / 12,000 ) - (4,500 / 10,000) X
12,000 X $80 = $144,000 F
(60% - 45%) X 12,000 X $80 =
Deluxe: (4,800 / 12,000) - (5,500 / 10,000) X
12,000 X $210 = 378,000 U
(40% - 55%) X 12,000 X $210 =

$234,000 U

CMA Canada 19
 APPENDIX A

Flexible Budget Variances

Direct Materials or Direct Labour Price Variance =

Actual price of Standard Actual quantity

- X
input price of input of input used*

*To isolate materials price variance at purchase point, use quantity purchased.

Direct Materials or Direct Labour Efficiency variance =

Standard quantity
Actual quantity of Standard price
- of input allowed for X
input used of input
actual output

Direct Materials or Direct Labour Mix variance for each input =

Actual input
Standard input Actual total quantity Standard
mix - X X
mix percentage of all inputs used price of input
percentage

Direct Materials or Direct Labour Yield variance for each input =

Standard total
Actual total Standard
quantity Standard price
quantity - X input mix X
of all inputs allowed of input
of all inputs used percentage
for actual output

Variable Overhead Spending Variance =

Actual cost per unit Standard cost per

Actual quantity
of cost- allocation - unit of cost-allocation X
of cost-allocation base used
base base

Variable Overhead Efficiency Variance =

Standard quantity of
Actual quantity of Standard variable
variable overhead cost-
variable overhead cost- - X overhead cost-
allocation base allowed for
allocation base used allocation rate
actual output

CMA Canada 20
Fixed Overhead Spending Variance =

Actual fixed overhead - Budgeted fixed overhead

Output-level variance =

Fixed overhead allocated

Standard fixed
Budgeted fixed using standard quantity of
- X overhead cost-
overhead cost-allocation base allowed
allocation rate
for actual output

Sales-price variance =

Actual units sold X Actual selling price - Budgeted selling price

Sales-Volume Variances

Sales-volume variance =

Actual sales Budgeted sales Budgeted contribution

- X
volume volume margin per unit

Sales-quantity variance =

Actual units of Budgeted units Budgeted Budgeted

all products - of all products X sales-mix X contribution
sold sold percentage margin per unit

Market-share variance =

Actual Budgeted average

Actual market Budgeted
X market - X contribution margin
size in units market share
share per unit

Budgeted average contribution margin per unit =

Budgeted contribution margin / Budgeted volume

Market-size variance =

Budgeted Budgeted average

Actual market Budgeted
- market size in X X contribution margin
size in units market share
units per unit

CMA Canada 21
Sales-mix variance =

Actual sales Budgeted

Budgeted sales Actual units of all
mix - X X contribution margin
mix percentage products sold
percentage per unit

January 23, 2008

CMA Canada 22